China’s ‘Too Big To Fail’ Economy

March 14, 2016 7 minute read

China’s ‘Too Big To Fail’ Economy

China’s ‘Too Big To Fail’ Economy

News of China’s structural weaknesses and economic slowdown have been leading global headlines since the shock 3% devaluation of the yen in August 2015. It came as no surprise then that the Financial Times stated that we are witnessing

“The demise of the economic growth model which has served the country until now”

Fenby, author of Will China Dominate the 21st Century cites heavy industry as the principle reason for their declining growth rates. However, if we are to consider the scale of the internal successes of China’s service industries, and analyse their capability for global success, an area of remarkable potential economic growth emerges. So, is China too big to fail?

Despite being run by a communist party, China appears much more capitalist. The regulation imposed on which businesses may operate within China is somewhat representative of communist values. Chinese businesses can export their services overseas, but for many industries, foreign competition is unable to enter China. This gives the state approved businesses unlimited access to China’s 1.357 billion population from which it can reap large profits to expand overseas.

Social Media Success

Tencent, the owner of WeChat, is one of the most successful internet firms in the world. Its stock market valuation crossed $100 billion in September 2013, less than two weeks after Facebook. Now, Tencent has bigger revenues and profits than Facebook, a large proportion of which originates only in China.

(Source: Economist)

WeChat has several hundred million users and its success lies in the nature of the market it is operating in. The Communist Party places strict controls on the social media market, restricting the use of Facebook, Snapchat, LinkedIn, Instagram. WeChat combines the idea behind these popular social media tycoons while remaining under strict state observation; effectively owns a monopoly on social media in China.

Tencent is currently building a bigger online platform for products and services and by the third quarter of 2015 profits rose by 32% to 7.45 billion yuan. With the size of their revenue and customer base, they have the capabilities to pursue global domination of the social media world. The innovative convenience of the app will attract social media consumers but its success in Western countries will largely depend on whether restricted privacy is too big a price to pay.

Financial services

The national state-approved monopoly is the case for many industries. The banking card industry is dominated by China Union Pay, which operates under the approval of the People’s Bank of China. Its international subsidiary, Union Pay is the 3rd largest payment network behind Visa and MasterCard, with revenues of $900 million in 2011. Union Pay cards can be used in 141 countries, but MasterCard and Visa, have only been allowed to minimum access to Chinese Markets, as of June 2015.

The World Trade Organisation ruled unfair discrimination on behalf of China’s discriminating policies against other payment processors. But the market already belongs to China Union Pay – MasterCard and Visa need to recruit from within the China UnionPay customer base meaning they ‘are starting at ground zero’. Chinese banks still do not issue Visa, MasterCard or American Express credit cards, and even so, few Chinese merchants have the capabilities to accept them.

(Source: FT)

This is communist style business strategy is exemplified in Foreign Direct Investment: Chinese investors can buy bonds outside of China but foreigners cannot by bonds inside China.

Too Big To Fail?

Furthermore, Tencent and China Union Pay are too big to fail industries. The term was coined in America for large institutions whose collapse was considered either too politically sensitive or to have far-reaching implications on the national economy. Given the significant levels of government investment in both companies, and their political sensitivity surrounding censorship controls, there can be no doubt that the Communist Party will bailout these companies for any level of corporate debt. Bailouts may promote excessive risk taking, but this is essential for a company who wants to expand overseas.

Hanergy Groupings is an example of a company that was so important to China’s political sensitivity that it was deemed too big to fail. The Financial Times journalist, Miles Johnson, who sought to discover the truth of Hanergy’s rapid increases of billions of dollars a week on the Hong Kong Stock Exchange, described the company as ‘a tale of a modern day corporate iqorous who soared on wings of debt and inflated stock valuations glued together with the promise of revolutionising the solar energy industry’. After its collapse last summer, the Chinese solar energy company was forced to shed 2,000 of his employees.

Hanergy was of particular value to the Chinese government given its ability to provide renewable energy to a country racked with environmental problems. The success of the Hanergy Thin Film was thought to be able to win the global race of renewable energy for the ‘Han’ people. Hanergy produced the first solar panelled car and was more valuable than all the international renewable energy resources combined.

While the company has denied financial intervention from the state, Bloomberg presents continued pieces of evidence to suggest the contrary. In 2011, two of China’s biggest policy banks helped with Hanergy’s financing extending a $4.8 billion line of credit to its parent, Hanergy Holding Group. The Export- Import Bank of China was given a standby letter of credit with a $82 million loan from 11 banks in December. Li Hejun, the companies former owner, was quoted in 2014 saying that “the government’s support of the photovoltaic industry shows they have faith in us. The development of the new industries will be impossible without the support of the government.”

Spiralling corporate debt in conjunction with overcapacity has been established as the principle reasons for China’s stock market collapse in August. As the Chinese Communist Party are increasingly absorbing the growing middle classes into their fold, the wealth of the controlling party is cumulative. With the ability to service any corporate debt deemed necessary in the maintenance of political stability, it seems unlikely that any significant Chinese slowdown is on the horizon. Overcapacity would be less frequent if China were to focus its energies on its service sector and their international development. The need for structural reforms has been flagged up, but the Communist party has proved capable of maintaining its controls over an increasingly privatised economic machine. The future growth of China is now all about pursuing their potential for global dominance in the service sector, and leaving behind the overcapacity in their heavy industries.

If we see the introduction of WeChat in Western societies in the next couple of years, it will only reiterate the strength of the Chinese market, in technology, innovation and economic power. China may be entering a period of slower growth, but following some structural changes, the success of its innovation drive may result in a period of more extensive growth. The service industry must overtake the manufacturing. China is on the verge of transitioning from a secondary to a tertiary economy, its spare capacity for growth is alarming. Renmin University championed China’s state-centric model

“If you look around the globe, China is still one of the fastest growing major economies”

The economy is slowing temporarily, but growth remains the fundamental to Chinese economic policy makers. Western economic interpreters should not underestimate the potential for future economic growth in China.

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